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Big Marijuana Embraced Convertibles. Now They’re Under Water

The bear market in pot stocks has left billions in convertible debentures underwater, meaning cash-starved companies may have to “creatively restructure” their debt or pay a bill they didn’t expect would come due.

Cannabis companies hopped into convertibles in the last three years when their stock prices were soaring and traditional debt markets were largely closed to the untested, unprofitable and stigmatized sector. Issuers that tapped the U.S. markets included Canadian pot giants Canopy Growth Corp., Aurora Cannabis Inc., Tilray Inc. and Aphria Inc.

Converts are a form of interest-paying debt that can be converted into stock at a set price. Investors generally buy them on the assumption that shares will appreciate, giving them the opportunity to convert at a discount. If they choose not to convert, companies have to repay the principal when they mature.

That was appealing when stocks were appreciating, but the recent rout in what had been high-flying marijuana stocks has left the shares far below the conversion price -- at just the time when cash-strapped companies are finding it tough to raise capital.

“We expect more companies with near-term maturities to attempt to creatively restructure their converts if they can,” said Neil Selfe, founder and CEO of Infor Financial Group Inc., a Canadian investment bank that’s active in the cannabis industry. “We are very busy on a number of restructuring and debt-related files given that the equity markets are closed.”

When Tilray announced its $475 million bond in October 2018, its conversion price of $167 -- when the embedded stock option would get triggered -- wasn’t far off from where shares were trading, roughly in the $140-$150 band. Its stock has since fallen 87% to $21, meaning investors hoping to convert are banking on a more than 700% rally.

Tapping the convertible market in the U.S. gave cannabis companies two significant advantages: a “quantum of capital” and access to an institutional investor base, said Iain Franks, head of convertible and equity-linked products at Cowen Inc. The convertible market in Canada is primarily driven by retail investors.

“Cross-listing equities to a U.S. exchange and tapping the U.S. institutional market provides issuers and investors with certain validation that the cannabis sector is real and investable,” Franks said.

There was a natural demand for cannabis convertibles in the U.S., especially from hedge funds that were quick to snap up the stocks, according to bankers familiar with the matter, who requested anonymity due to sensitivities surrounding the marijuana market.

But cannabis companies’ high-risk credit profiles meant terms were generally less favorable than other issuers, at a time when the pricing environment had been stronger than ever.

The summer of convertibles in 2019 meant tech companies like Snap Inc. or industrial issuers such as Fortive Corp. could get sub-1% coupons and 40%-plus conversion premiums. Meanwhile, cannabis convertibles -- many of which aren’t due to mature until 2023 -- have had 4%-plus coupons and sub-25% conversion premiums.

“For investors, given how far out-of-the-money the notes are and current trading prices, the securities trade more as a fixed-income substitute with higher yield,” Franks said. “For the issuing companies, unless the valuations recover to 2018 levels, it means the securities will need to be refinanced at some future point.”

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